There has been a trend over the past 25 years of US companies pursuing a strategy of diversification through acquisition. The wisdom behind this process is the mitigation of economic risks from heavy investment in limited sectors or markets. The hope with diversification is that the rise and fall of business within one market will not be catastrophic to the parent company due to the stratification of that business across many companies.

The many forms of diversification

Diversification acquisition is sometimes used as a tool to boost shareholder confidence and to boost stock prices and earnings growth. The addition can be used to strengthen an established portion of the company or to reduce the company’s reliance on the stability of a specific market. Here are some of the forms of acquisition that companies employ:

  • Unrelated companies: In some cases, the purchase of a company (or companies) in a separate industry to the parent company creates synergies for the promotion of company growth and to reduce the risks in other aspects of the company. This kind of diversification, if implemented correctly, can produce a safety net that could allow higher risk tolerance in certain areas of business, which may be helpful for specific operations activities or company changes.
  • Mergers and acquisitions: This form of acquisition is often used to find those companies that can complement and improve the functioning, production or business activities of other operations within the same economic sector and industry.

Misconceptions of stabilization and growth

These forms of acquisitions do not necessarily increase earnings growth or reduce business risk immediately. Often the benefit of diversification is a long-term strategy for reducing business risk. For many companies, an acquisition will not create larger returns, earnings or capital appreciation compared to the company’s acquisition valuation, but will promote slower growth or stability gains. Unrelated investments are also not necessarily the best strategy for a business to reduce business risks, as the liabilities of the parent company can affect each portion of the conglomerated company. If your company is considering acquiring more vertical or horizontal businesses, you should contact an attorney with experience in business law and acquisitions to explore your options and liability profile.